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The Building Bubble in China

Beijing - Jack Rodman has cashed in on property busts from Los Angeles to Tokyo, buying and selling soured loans and counseling other investors. Now he's convinced the Beijing real estate market is about to tumble. Rodman figures about half of the city's commercial space is vacant, and to prove it he keeps a slide show of 55 empty office buildings in the Chinese capital on his computer. There are an additional dozen, he says, that he hasn't had time to photograph. "I took these pictures to try to impress upon people the massive amount of oversupply," says Rodman, president of Global Distressed Solutions, which advises investors on Chinese property.

Much of the $1.4 trillion in loans made by Chinese banks last year—with considerable encouragement from officials aiming to boost growth—was spent on skyscrapers and other commercial property. Now empty buildings are sprouting across the mainland. Beijing had an office vacancy rate of 22.4% in the third quarter, the ninth-highest of 103 markets tracked by broker CB Richard Ellis (CBRE) (CBG). That figure doesn't include projects about to open, such as the 74-story China World Tower 3, Beijing's tallest building. "There's a monumental property bubble and fixed-asset investment bubble under way," says James Chanos, founder of New York hedge fund Kynikos Associates. "And deflating that gently will be difficult at best."

Worried Beijing policymakers are trying to choke off the supply of funds fueling the property boom. On Jan. 27, the China Banking Regulatory Commission, the chief oversight body, called on banks to curb loan growth. They should "strictly" follow real estate lending policies, the commission said in a notice on its Web site. "The Chinese authorities are clearly trying to bring excessive bank lending under control," says Stephen Roach, the chairman of Morgan Stanley Asia (MS).

HIDDEN EXPOSURE

The central bank on Feb. 12 increased reserve requirements, the money banks must keep on hand to cover potential losses, for the second time this year. That should reduce the amount of money banks have available for new loans, helping to slow growth. Now some economists are speculating that the government could allow China's currency, the yuan, to appreciate against the dollar for the first time since July 2008. "They're close to moving the exchange rate. I think something's brewing," says Jim O'Neill, London-based chief global economist at Goldman Sachs (GS).

If Beijing can't cool things off and the property boom turns to bust, there could be a surge in nonperforming loans. A 10% fall in property values would triple the number of delinquent mortgages in Shanghai, regulators in the city said on Feb. 4. The damage could be worse than expected because some industrial loans to state-owned companies have been used to invest in real estate, says Charlene Chu, an analyst at Fitch Ratings in Beijing. "There is a lot more hidden property exposure there than we can see," Chu says.

Despite the bubble talk, some analysts say the worries may be overblown. CBRE says vacancy rates are starting to fall and rents are rising for the best buildings as China's growth buoys demand. "In many cases when you look at these buildings and say, 'That's never going to be fully occupied,' somehow 12 to 18 months later the building is full," says Chris Brooke, CBRE's Asia chief.

Builders, meanwhile, continue to build. Some 13 million square feet of new office space will enter the market in Beijing this year, increasing the total stock by about 13%, according to real estate adviser Jones Lang LaSalle (JLL). "We are optimistic about 2010 prospects," says Zhong Rongming, deputy general manager of the China World Trade Center Co., which developed the $965 million China World Tower 3. "China is taking the lead in the global economic recovery with a very positive economic outlook."

Many of the new projects are being built with help from local governments. In eastern Beijing, officials are hoping to double the size of a vast development called the Central Business District, even though its vacancy rate is 35%. Financial Street Holding, whose biggest shareholder is an arm of the municipal government, has plans for 10 million square feet of additional space starting this year.

GATHERING DUST

A mile or so east of Tiananmen Square, the five towers of the Minsheng Financial Center remain nearly empty more than a year after leasing began. Across town, take a walk down Financial Street, and you'll pass No. 9, a 17-story concrete-and-glass tower that's unoccupied. One block south, no lights shine from Nos. 12 and 16, the two towers of the 18-story China Life Plaza. Two blocks farther on are another pair of 18-story buildings, Nos. 20 and 22, belonging to the Bank of Communications. Dirt is gathering at their doors, and a lobby is being used as a parking area for bicycles.

No. 8 Financial St., by contrast, has a new tenant. A company called China Huarong Asset Management has put up its corporate flag and red lanterns in celebration of the Lunar New Year. While any activity on that desolate stretch should cheer those who fear a bubble, Huarong's arrival may do more to fuel their concerns than to allay them. Its mission: selling bad debt from banks.